Senator Has Questions For NASD

By GRETCHEN MORGENSON

Published: December 1, 2006

Charles E. Grassley, the Iowa Republican and departing chairman of the Senate Finance Committee, has asked NASD, the securities industry's largest self-regulatory organization, to describe in detail how it identifies and tracks possible insider trading among its members.

Mr. Grassley's staff is investigating the Securities and Exchange Commission's handling of an insider-trading case involving a prominent hedge fund. The questions being asked of NASD indicate that Congressional scrutiny of the nation's market regulators is growing.

Insider trading appears to be a growing problem for regulators. In August, The New York Times reported that an analysis of the nation's biggest mergers during the last year found abnormal trading in the securities of 41 percent of the companies in the days and weeks before the deals became public. Those buying shares during these periods of unusual trading generated gains of as much as 40 percent.

''This oversight effort is about making sure the watchdogs are getting the job done,'' Mr. Grassley said in a statement. ''It's about maintaining public confidence in the system by making sure the average Joe investor is on equal footing with big shots on Wall Street.''

Mr. Grassley sent his request to Mary L. Schapiro, the chairwoman and chief executive of NASD, in a letter on Tuesday -- the same day that NASD announced that it was merging its oversight operations with those of the New York Stock Exchange.

He asked that NASD respond to his questions about its regulatory approach by Dec. 18.

The letter from the senator parallels his September request that the Government Accountability Office investigate how the S.E.C. polices the financial markets and pursues insider-trading cases. The G.A.O. agreed last month to conduct a broad review of S.E.C. enforcement practices and those of its office of compliance, inspection and examination, which oversees money managers.

The G.A.O. has until June 2007 to issue the report.

Mr. Grassley asked NASD to describe its market surveillance tools, its sampling methods for capturing unusual trading around a market-moving event like a merger, its approach to repeat offenders and how it ensures that it ''casts a wide net during market surveillance and oversight.''

NASD was also asked to describe the types of enforcement actions it takes, the frequency of such actions and the degree to which the organization's enforcement efforts are overruled by the S.E.C.

Under its proposed merger with the New York Stock Exchange regulators, NASD will oversee securities firms, arbitration and the licensing of brokers, while the exchange's regulators will conduct market surveillance and compliance for companies whose shares trade on the exchange. Both the S.E.C. and the NASD's membership must approve the deal; if they do, Ms. Schapiro will become chief executive of the combined entity.

A spokeswoman for Ms. Schapiro said she declined to comment.

Others in Congress are also interested in the apparent increase in insider trading. The Senate Judiciary Committee, overseen by Arlen Specter, a Pennsylvania Republican, until Congress changes hands next year, is expected to hold a hearing on Tuesday on the oversight of insider trading.

Mr. Specter convened a hearing on the subject in September, at which a New York Stock Exchange official said that there was a significant increase in the number of insider-trading referrals submitted by the exchange to the S.E.C. in the last two years.

The request for information from the NASD comes amid an inquiry by Mr. Grassley's staff and the Senate Judiciary Committee into the S.E.C.'s handling of an insider-trading investigation involving Pequot Capital Management, a $7 billion hedge fund run by Arthur J. Samberg. That investigation, which began in 2004, centered on a number of profitable trades Pequot made in advance of mergers or other market-moving news.

The Pequot inquiry was overseen by Gary J. Aguirre, a former staff lawyer at the S.E.C., who has told the Senate that his superiors blocked him from interviewing John J. Mack, an influential Wall Street executive and a friend of Mr. Samberg. Mr. Mack now heads Morgan Stanley.

Last summer, the S.E.C. took Mr. Mack's testimony in the case. In October, it advised Mr. Samberg and Mr. Mack that it would not recommend any enforcement actions against them and closed the Pequot investigation. Mr. Samberg and Mr. Mack have repeatedly denied any improper conduct.

S.E.C. officials had argued that Mr. Aguirre could not demonstrate that Mr. Mack had inside information and was therefore not justified in taking his testimony as part of the investigation.

Mr. Aguirre, who said he was simply interested in getting information from Mr. Mack, protested the decision and was fired in September 2005, a year after he was hired.

In addition to questions relating to NASD's market surveillance techniques, Mr. Grassley asked NASD to describe its procedures for preventing brokerage firms from retaliating against analysts, brokers or other employees, and protections that exist for whistle-blowers at NASD member firms or the regulator itself.

How NASD manages its extensive broker disciplinary records is another topic of interest to Mr. Grassley. He asked NASD what procedures it had to ensure that the information it provided to the public was accurate and asked what efforts NASD had made to upgrade this program.

''What has the NASD's response been to private sector initiatives aimed at improving investor awareness of brokerage wrongdoing?'' Mr. Grassley asked. ''Is the NASD of the opinion that it is the sole party entitled to deliver such information to the investing public?''